JUNE 2013 China’s innovation engine picks up speed Gordon Orr and Erik Roth Meaningful advances are emerging in fields ranging from genomics to mobile apps— and what’s happening beneath the surface may be even more significant. Back in 2011, when we began work on a McKinsey Quarterly article called “A CEO’s guide to innovation in China,”1 much of the debate was about whether the country was more likely to become innovative or to remain a fast follower of foreign leaders. Even then, that seemed like yesterday’s question. Companies in China were innovating; we were seeing that every day in areas such as renewable energy, consumer electronics, instant messaging, and mobile gaming, both at domestic players and at multinationals with signi- ficant research and product-development presences. Nothing that has happened since has changed our view. Indeed, our sense today is that the pace of innovation is quickening and that a new spirit of innovation is spreading across sectors into universities and even into key departments of the Chinese government. In a recent series of interviews with executives at Chinese companies, we detected evidence of real innovation leadership and the potential for more to come. John Oyler, CEO of the three-year-old Chinese biotech company BeiGene, for instance, underscored the attitude— “anything is possible, we can make it happen, there is no challenge we cannot conquer, we will surprise the world”—that he’s now seeing among Chinese scientists at his company. In fact, a wide range of companies have begun mounting challenges in sectors traditionally the preserve of US, European, Japanese, 1 Gordon Orr and Erik Roth, “A CEO’s guide to innovation in China,” McKinsey Quarterly, 2012 Number 1, mckinsey.com. 2 or South Korean businesses. Beijing Genomics Institute (BGI), for example, the world’s biggest genetic-sequencing company, now claims to account for roughly 50 percent of global capacity and probably sequences more genetic material than Harvard University and the Massachusetts Institute of Technology combined, while developing some of the world’s most advanced biologic-computing models. In information and communications technology, Huawei attracted attention at this year’s Consumer Electronics Show, in Las Vegas, with innovative new smartphone platforms built on chips and software designed in-house. Another smartphone player, Xiaomi, founded in 2010 and often compared to Apple for its marketing strategy and loyal following, is on track to sell more than 15 million phones this year. Midea surprised its industry recently by announcing a highly efficient 1-hertz variable-speed air- conditioning compressor ahead of foreign competitors. And YY.com, a voice-based communications and gaming service, has captured growing attention with its mass online karaoke. In our previous article, we suggested that tomorrow’s winners in China would focus on infusing their innovation efforts with a more sophisticated understanding of Chinese customers, retaining local talent, instilling a culture of risk taking, and promoting internal collaboration. This list remains crucial, but it is incomplete. In this article, based on recent interviews and our work with dozens of Chinese companies, we want to highlight three more recent developments that are likely to shape the innovation environment during the years ahead: the growing role of Chinese universities in the local innovation ecosystem; the gathering local interest in, and concern about, intellectual-property (IP) protection; and the emergence of a new generation of talent. If we are right that these forces are accelerating China’s realization of its innovation potential, then embracing them is mission critical—for Chinese companies and multinationals alike. 1. Seek Chinese universities as innovation partners The prevailing view of Chinese universities is that they are highly effective at turning out large numbers of reasonably well-qualified 3 specialists whose strengths are in the application of existing practices to predefined problems and whose future may lie in shanzhai (“copycat”) innovation. But that picture is changing rapidly, with the best universities starting to recruit the world’s top faculty talent for priority disciplines and creating an environment where break- throughs can happen. When Fudan University wanted to develop a wastewater-treatment science program, for example, it hired one of the world’s top thinkers on the topic, who was teaching and conducting research in Singapore at the time. Globally recognized scientific journals are also increasingly filled with publications from leading Chinese researchers: Nature, for example, published 303 papers by Chinese scientists in 2012, up from 46 in 2006. As Chinese universities raise their game, they are becoming increas- ingly interesting innovation partners for a wide range of domestic and global companies. To some extent, this is nothing new: Intel, for example, has long collaborated with these universities to sponsor research projects, PhD theses, and technical forums related to tech- nology that’s close to the company’s business. What seems to be changing is the growing use of Chinese universities as a form of “outsourced R&D,” to borrow a phrase from an executive we interviewed recently. One Chinese packaged-goods company conducts food-science research almost entirely through the labs of a local university. Pei-Yuan Peng, vice president and head of LG Electronics’s Shanghai-based R&D center, recently described for us the range of joint-research efforts his company undertakes with leading Chinese university labs and the role that Chinese professors play in helping LG recruit the best and brightest Chinese researchers and engineers. Meanwhile, in the life-sciences sector, BeiGene’s Oyler describes Chinese universities and research institutions as underappreciated treasure troves of innovation pockets. Oyler’s team actively collaborates with scientists at the National Institute of Biological Science located across the street from BeiGene’s headquarters and full of creative, passionate world-class scientists. Last year, the institute (headed by Xiaodong Wang, a member of the US Academy of Sciences) dis- covered the hepatitis B virus receptor—a huge advance against one of the most common chronic diseases in Asia. Researchers from the two organizations trade ideas in both formal and informal meetings.2 2 “NIBS scientists identified a functional receptor for hepatitis B and D viruses,” www.nibs.ac.cn/en/research_news/elife.html, November 2012. 4 There are risks for multinationals, to be sure. Many Chinese universities have strong ties to the government, whose prioritization of domestic innovation may discourage close and open work on advanced topics. As LG’s Peng points out, though, those ties also mean that Chinese professors often pick up valuable information from government officials about changes in policy direction and market rules. Multinationals that make Chinese universities part of their innovation ecosystem are likely to gain earlier access to these insights, too. 2. Make intellectual-property protection a core part of innovation culture The government has become noticeably more active in its support of intellectual-property protection. Gao Feng, deputy director of the Ministry of Public Security’s economic-crime investigation department, has been describing, with surprising openness, the weaknesses of the current IP system and vowing continued improvements.3 The Chinese government ministry charged with prosecuting intellectual-property violations recently announced that it handled 2,347 cases in 2012, up almost 40 percent from 2011, and over those two years resolved $2 billion in violations.4 And in Jiangsu Province, the local government in Suzhou is building a 500,000-square-meter facility next to its innovation park. The idea is to bring together IP-related agencies and leading technology companies to elevate IP issues in importance, while improving the processing and quality of patent approval and protection. Efforts such as these, while localized, reflect a growing appreciation for the importance of IP protection. Nonetheless, intellectual-property theft—including the reverse- engineering, copying, and sale of components and finished products—remains a concern, particularly for multinationals. Many continue to report deliberate cybersecurity breaches by Chinese hackers trying to steal valuable secrets over corporate computer 3 Wang Xiaodong, “Progress in fight against fake products,” chinadaily.com.cn, January 23, 2013. 4 Ibid. 5 networks and across national borders. Interestingly, savvy Chinese companies are already working hard to protect themselves. One priority: creating physical barriers to piracy. We’ve seen companies forbidding the use on their campus grounds of PCs, mobile devices, and other electronics not issued by the company. Precautions might extend to not allowing laptops or smartphones to enter or leave the campus, for fear that they might carry sensitive material, and restricting the most sensitive engineering activities to buildings where wireless access is blocked, computers are tied down to desks, and there is no access to external networks. Other practices include compartmentalizing knowledge so that only a few individuals have a complete understanding of complex core systems. It is increasingly common to require camera-enabled devices to be stored under lock and key before entering R&D facilities. Many companies have also banned the use of devices, such as portable hard drives